How Your Credit Score Affects Loan Interest
The rich get richer. It’s a common phrase generally meant to mean that it seems wealthy people have an easier time generating more income. They catch all the breaks. Similarly, it seems like those with good credit catch all the breaks when it comes to getting lines of credit. It’s easier for them to qualify, and they get lower interest rates.
Good Credit Gives You Privileges
A person that has good credit has a low statistical probability of defaulting on a loan. Therefore, they are given a lower interest rate. A person with a lower credit score has a much higher probability of defaulting, therefore they are charged a much higher interest rate to cover the losses incurred by lenders by those who do default.
How much does a lower credit rating cost a person in interest when taking out a loan?
For an example, I will use a $10,000 unsecured personal loan with a term of 5 years and calculate the amount of interest paid as the rate is increased due to a less desirable credit score:
If someone has a great credit rating, they will get the lowest interest rate. As an example, let’s say the interest rate given is 7%.
Over the course of 5 years, the amount of interest paid on a $10,000 with a rate of 7% is $1880.72
If someone has a credit rating in the middle (not bad, but not great) they will get a somewhat higher interest rate. As an example, let’s say the interest rate given is 11%.
Over the course of 5 years, the amount of interest paid on a $10,000 loan with a rate of 11% is $3045.45
If someone has less than desirable credit, they will get the highest interest rate. For our example, let’s say they are approved for the loan, but with an interest rate of 15%.
Over the course of 5 years, the amount of interest paid on a $10,000 loan with a rate of 15% is $4273.96
There is some truth to the phrase, â€œThe rich get richer.â€ If you have wealth, it can be easier to generate more wealth because you have the means to take advantage of more opportunities. People with good credit also have an easier time keeping and improving their credit because they get lower interest rates, which lowers their monthly payments. This makes loans easier to pay back, and keeps more money in their pockets.
How about you, Clever Friends, have you ever been given an unusually high, or unusually low interest rate due to your credit rating?
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Brock is a software engineer by day and personal finance blogger at night. He is a fitness junkie and enjoys grilling and smoking meat. Married with two children, Brock strives to improve his skills as a husband and father, and is always on the lookout to stretch his family’s budget as far as he can.